SP500 - The Mona Lisa

This is the final in a series of 3 posts I have done on pattern targets and I have saved the best for last. The chart below is a 10 year look back at the SP500 (the proxy most use for the US stock market). From a target and pattern standpoint, it is a thing of beauty and one to behold since the 2009 bottom.

As it rose from the depths of its decline, making higher highs and higher lows, a series of 4 inverse head and shoulders patterns developed (labeled in red 1-4 within the price movement) along the way. From those patterns, targets were developed which I have identified and labeled by red, dotted horizontal lines. These patterns not only acted as a potential roadmap to the future confirming along the way which direction we were headed but also where we might stop along the way. These stopping points create significant support/resistance levels for future any declines.

As you are aware, the final target, #4 of 2132 has yet to be met. Since targets are only objectives if the market to continues higher but we got confirmation from another indicator in April (see RSI top pane) that at least one more high will be made. While 2132 is a ways away and may never be hit, one thing I am confident of and have said before is the market likes big, round numbers. SP500 = 2000 is a big, round number and we are only ~2% away. With quarter-end right around the corner and wall street bonuses paid on quarterly gains, I do expect to see a bullish close to this month and would not be surprised to see we close it out at or above 2000.

Whether or not we meet or exceed the final target #4 will only be known at some point in the future. Since it has been an extended period since we have had even a normal 10% pullback, the odds suggest we have one before the final target is hit or exceeded. My point being it most likely will not be a straight line there so patience is warranted.

To close out this discussion on pattern targets on an educational note, its compelling to note that prior targets act as magnets on any future pullbacks.  So, if/when we do finally get our long, overdue correction I would expect price to be drawn to 1820 (an immediate level of support/resistance) and if that doesn’t hold, target #3, 1775.

Oil - Double Bottom ... again

Last week I presented the concept of forecasting future price targets based upon patterns which develop within price movement.  To illustrate, I used a long term chart of the Nasdaq which had created a pattern in 2011 that projected a future price that came within 2% of the forecast.  While the accuracy was most excellent what I find very compelling is the chart identified this price 3 years before it happened.

This week I want to show not only a different pattern but also that price projections work across all investment types (since many don’t just invest in stocks and bonds).  The chart below is a 3 year look at the daily price of crude oil. You can see in the highlighted area on the left hand side of the chart a double, divergent bottom formed in 2011. I have included the pattern’s projected price target in a callout box, which forecasted a high of 103.82. Price topped out 5 months later in March at 109.45, exceeding the target by 5%.  While that is pretty good, it fell short of last week’s 2% miss on the Nasdaq

If you let your eyes drift to the right side of the chart you can see another highlighted area where the exact same divergent, double bottom has formed. This one started at the end of last year and has yet to complete.  The upside target of this pattern is just under $109/bbl. Experience tells me that I should expect this target to fall short of the actual high we eventually see. Why? Because oil is a highly geopolitical “tool”, sensitive to Middle East disorder. In addition, it is a relatively thinly traded market making it subject to price swings. So, while I stated above that patterns work across all investment types, I find price projection accuracy can be quite variable when using vehicles outside of those which are highly liquid such as stocks and bonds. This does not mean they should be ignored. Au contraire, like any technical analysis it should be used in conjunction with other tools to create the most profitable investment plan. 

In the meantime, keep oil on your radar and let’s circle back around and see how this pattern actually plays out. If I were a betting man, based upon the latest geopolitical cross-currents, I would put my money on a big miss to the upside as I expect price will exceed the target and maybe even by double digits.  Remember, news ALWAYS trumps the charts.

The Nasdaq - 3 years later

Many wonder why market technicians spend so much time analyzing charts. The main reason is a skilled analyst can find opportunities, warnings and most importantly expectations of the future buried in price movement. Over the next couple of weeks blog posts I am going to not only go dust off some old charts I created a few years back (when I first started work on my CMT designation) and see how they are playing out but also introduce a few new ones.

This week let’s start off with an old chart I created at the start of 2012 and have presented every year since then of the U.S Nasdaq market. At the start of 2012, based on the prevalent bullish pattern that developed after the 2011 (-20%) pullback, the price objective of that pattern pointed at 4413.  At the time the Nasdaq was about 2900 as you can see. I didn’t want to believe it. After analyzing and reanalyzing because of my disbelief, I thought to myself there had to be something wrong with the chart. If not the chart, it had to be me. I had to be either drawing or interpreting it incorrectly. There was no way it was going to go up an additional 50% from there. Jump forward almost 3 years and we can see the high created earlier in March of this year topped out at 4336. That is less than 2% away from the pattern target. If you are like me, you are wondering if now that it hit its target is that the end of the run or do we need more time to see if it can push higher?

With 3 years of additional data (and experience) to complement the original chart let’s see what, if anything, it may be telling us. In February the oscillators warned (negative divergence in red) correctly of a pullback … which eventually occurred. Subsequently, the oscillators (reverse divergence in green) are advising of the probability at least one more new high will be made. The price objective of that new high is 4460 (not much above the original target of 4413) but could extend as high as 4740.  The reason why I have a range for the next target and I had one specific price on the original is that I am using a different pattern this time to develop the new target price. With this pattern there are two different, acceptable methodologies to calculate the target and as such, I have provided both.

In case anyone is wondering … No, technical analysis does not always give answers that work out as well as this one. What it does do though, is provide a toolset that should, if used correctly, give the user an advantage over the majority of market participants.  It is merely a windsock.

Next week I will pull out the old chart of the SP500 I created back in 2012 at the same time as the Nasdaq chart and see what the old windsock is telling us.

Margin debt and how I was wrong

A man must be big enough to admit his mistakes, smart enough to profit from them, and strong enough to correct them. - John C. Maxwell

I was wrong. There, I said it.

Over the past few years many market technicians (including myself) were looking at the continuously increasing new highs in margin debt as a warning sign stocks were topping.  In retrospect and having a different perspective I have concluded we were wrong.

There is no arguing, margin is fuel to the bull market fire. For those not aware, when investors/speculators run out of their own money to invest, they can borrow from their brokerage institutions against a portion of their brokerage account. As long as they can make more money than the costs to borrow it can make sense to use margin.  The times it becomes a problem is when those same investors/speculators have 1) reached their borrowing limit or 2) if stocks decline. If investors have no more money to invest (whether from their own sources of funds or borrowed on margin), the market runs out of buyers and can go no higher. If stocks decline margin investors are forced to sell positions to pay off the outstanding margin debt which is being demanded from their broker. Since they have no remaining liquid funds (all funds are fully invested) this forced liquidation adds more sellers which of course, drives the market down even further.  And on it goes, potentially snowballing. Where the level of margin debt really matters is that the greater the margin debt, the greater the possible decline.  

Back to being wrong … My view had always been because margin debt reached a new high it could not go higher and so stocks had to decline. As it turns out that thinking was completely wrong and where I should have focused my concern was not at whether it was making new highs (because that is actually very bullish) but rather if margin debt CHANGES DIRECTION and starts to decline.  Going higher has the effect of pushing prices higher, falling margin has just the opposite effect.  It seems so simple now, what the heck was I thinking?

This leads me to this week’s chart which is that of a historical look back at margin debt updated through the first quarter of this year.  The red line is the US Stock market (SP500) and the blue line is margin debt.  What I would hope you take away from this chart is at least the following

1)    Rising margin debt = rising stock prices

2)    Falling margin debt = falling stock prices

3)    Peaks in margin debt have coincided with peaks in the stock market

4)    Margin debt peaks first

Now you have that firmly ensconced in your brain, ask yourself this, “is the decline in margin debt from the start of this year a temporary blip or the start of a new trend?”  Don’t know the answer? Me either but I do know this, it is not the time to be attempting to be a hero and taking on excessive risk.

April 29, 2014 - Household debt

I was traveling and apologize for the late post but bad weather (Arkansas tornados), remote location and delayed travel hindered me from actually being even a little productive. As such this week’s blog post is not from me but rather a recent one Tom Mclellan posted which I thought was quite interesting and definitely worth watching going forward. If you have not visited his site or aware of his work, I would encourage you to dig a little deeper at www.mcoscillator.com

Debt is bad, at least for you and me.  But debt held by others can be a wonderful thing, as long as it is increasing. Debt is only a problem at the point somebody decides to do something about it.

The unfortunate fact for stock market investors is that household credit market debt as a percentage of disposable personal income has been shrinking ever since the peak back in 2007.  Normally it is bullish for stock prices to see household debt increasing, and bearish to have household debt decreasing.  But occasionally the two can go in opposing directions, which is the condition we see right now.

Historically when such a divergence has happened, the stock market eventually realized that it had wandered off track, and it worked extra hard to get back with the program.  But here we are, almost 7 years into a decline in household debt versus income, and thus far the stock market shows no sign of recognizing its off-track condition.  It is a bigger and longer divergence that we are accustomed to seeing in past episodes, such as those labeled in the chart.  The most likely explanation is that the Fed is helping to push up asset prices, in hopes that such action will eventually help push down unemployment rates and other indications of economic malady, and that this action by the Fed is continuing the divergent condition much longer than normal. 

The Fed's data on household credit market debt only extend back 62 years, which is just barely one interest rate cycle period, but is still a pretty long period of time.  And in that time, there has never been an instance of stock prices moving up while the debt to income ratio moved down that did not resolve itself by having stock prices moved hard downward to get back on track.  I do not see it as good news that the stock market is now going for its longest divergence ever in this regard.  I instead see that as a sign of trouble that will eventually have to be paid back double once the reckoning commences. 

It is understandable at this moment in history that we are seeing debt decrease, or perhaps I should specify PRIVATE debt.  U.S. government debt, on the other hand, has doubled in the past 8 years.  Through either willful action or neglect, Congress has been taking up the slack in the debt market.  But while Congress is still on a spending spree with other people's money, Baby Boomers are facing retirement from an ever closer vantage point, and realizing that piling up 2nd and 3rd mortgages on McMansions is not a great way to prepare for the day when the paychecks stop coming.  So they are doing the wholly rational action any reasonable person would do, increasing their savings and reducing their debt. 

The big problem, though, is that there are a whole lot of us Boomers trying at the same time to reduce our debt and get ready for retirement.  The "echo boomers" and millenials are not feeling any compulsion to take up the slack.  They would rather live in Mom & Dad's basement than take out their own mortgage to relieve the Boomers of those McMansions, which leaves the housing market moribund, the banking system seeking yield wherever it can find it, and the Fed trying to fill the void with free money.  So far that has not reached a trigger point that would cause the stock market and the banking system to reverse course, but I have to figure that such a reckoning day is coming.  It always has before, eventually.  And if the crude oil leading indication is right, it could take until 2018 before that reckoning point will appear and start to matter. 

Ironically, if Congress ever decides to mend its ways and step back from the ever-increasing debt levels, then history shows that the stock market could be in for real trouble.  As long as we are spending somebody else's money for whatever we want, the party goes on.  The only time that the problem manifests itself is when somebody tries to do something to solve the problem.